Deference Principles: Tax Litigation’s Next Battleground

The Supreme Court’s recent decision to grant certiorari in the case of James L. Kisor v. Peter O’Rourke, Acting Secretary of Veteran Affairs, and revisit the question of whether an administrative agency’s interpretation of its own ambiguous regulations is entitled to deference, could have a cascading effect on deference principles in general. In the tax arena, this development has wide-ranging implications for tax planning and litigation matters going forward. Although taxpayers and tax professionals have wrestled with deference issues for years, this development takes on added importance given the major recent changes to the tax laws and Treasury’s tremendous effort to draft thousands of pages of regulations in response.

In our federal tax system, Congress enacts the tax laws. According to the Internal Revenue Manual:

It is the duty of the [Internal Revenue Service] to correctly apply the laws enacted by Congress; to determine the reasonable meaning of various Internal Revenue Code provisions in light of the Congressional purpose in enacting them; and to perform this work in a fair and impartial manner, with neither a government nor a taxpayer point of view.

This is accomplished through the issuance of published guidance — regulations, revenue rulings and revenue procedures, notices, and announcements — and private guidance — letter rulings, determination letters, technical advice memoranda, chief counsel advice, etc. — by the U.S. Department of the Treasury and the IRS. The IRS’ Office of Chief Counsel is tasked with enforcement of the Internal Revenue Code.

An agency’s ability to issue binding guidance is generally subject to various judicial doctrines, which can be grouped into three levels commonly referred to as Chevron, Skidmore and Auer deference.[1] A logical, but sometimes overlooked question is what is meant by the term “deference.” Importantly, “[d]eference does not mean acquiescence.”[2] However, depending on the type of administrative guidance, courts may treat an agency’s interpretation as binding so long as it is reasonable — even if another interpretation may also be reasonable, or even more reasonable. As explained below, whether to afford deference and the level of deference depends on the context of the agency’s interpretation and the medium in which it is made.

Chevron is the highest level of deference and traditionally has been applied to tax regulations. Eligibility for Chevron deference generally requires an ambiguous statute and a reasonable interpretation of the statute. If both requirements are met, a court will apply the agency’s interpretation, regardless of whether the court might believe that another interpretation is also reasonable — and possibly even more reasonable.

Skidmore deference has traditionally been applied to other forms of published guidance such as preambles to regulations, revenue rulings and procedures, notices and announcements. Eligibility for Skidmore deference depends on the level of persuasiveness, i.e., whether the IRS’ interpretation is thoroughly considered, well-reasoned and consistent with prior and subsequent IRS positions. Unlike Chevron deference, there are no set requirements to satisfy before a court will defer to the agency’s position; rather, the court will look at several factors and determine whether, under the circumstances, it should defer to the agency’s interpretation.

Finally, Auer deference is a unique standard that potentially applies to IRS interpretations of the IRS’s own ambiguous regulations. If certain conditions are met, the IRS’s interpretation will be afforded controlling deference based on the theory that the agency is the best party to interpret its own regulations. Similar to Chevron deference, so long as the necessary requirements are satisfied, a court will accept the agency’s interpretation even if it believes another interpretation is also reasonable.

Whether an administrative agency should be afforded deference, and the level of that deference, has been litigated in many contexts over the years. In recent years, the continuing vitality of deference doctrines has been questioned in both tax and non-tax cases. Guidance issued in the wake of the Tax Cuts and Jobs Act of 2017[3] and the change in membership of the U.S. Supreme Court have put these doctrines front and center for future tax disputes.

The Role of Deference Principles

The role of Auer deference in tax disputes was dormant for many years. However, the issue gained traction in recent years as a litigating tool as the IRS and the U.S. Department of Justice began to more regularly argue that their interpretations in legal briefs of ambiguous tax regulations should be afforded controlling deference. Trial and appellate courts have tended to be receptive to these arguments.

However, the Supreme Court in several cases over the past decade has slowly whittled away at the doctrine by providing limitations on how and when the doctrine can be used. For example, in addition to the requirement that the regulation be ambiguous: (1) the interpretation must not run counter to the agency’s intent at the time of the regulation’s promulgation, (2) the interpretation must reflect the agency’s fair and considered judgment on the issue and cannot be a convenient litigating position or a post hoc rationalization designed to defend past agency action against attack, (3) the regulation cannot merely parrot or restate the statutory language so that the agency, under the guise of interpreting the regulation, creates de facto a new regulation, (4) the interpretation must not be an unfair surprise or one that imposes a new liability for past actions taken in good faith reliance on prior agency announcements or positions and (5) in the tax context, deference may not be available unless the IRS’ interpretation is a matter of public record and is an interpretation that taxpayers are entitled to rely upon when planning their affairs.

Auer deference is also arguably at odds with two well-established canons of statutory construction.[4] The first — the rule of lenity — provides that penal statutes should be construed in favor of more lenient punishment. This rule has been applied in the civil tax context, both by the courts and by the IRS. The second — the strict construction canon — provides a general rule that ambiguities should be construed against the drafter. Courts have applied this rule in the context of ambiguous regulations.

Even Chevron deference has not been immune from attack in recent years, including by Congress and some judges. In 2017, the Separation of Powers Restoration Act[5] was introduced in the Senate to repeal Chevron deference, and presumably Skidmore and Auer deference, by amending the Administrative Procedure Act to require reviewing courts to determine “de novo all relevant questions of law, including the interpretation of constitutional and statutory provisions and rules.” A similar measure, named the Regulatory Accountability Act of 2017, was passed in the House of Representatives in 2017. And, in a recent concurring opinion in Pereira v. Sessions,[6] Associate Justice Anthony Kennedy cited concerns by Associate Justices Clarence Thomas and Neil Gorsuch regarding Chevron deference and observed that “it seems necessary and appropriate to reconsider, in an appropriate case, the premises that underlie Chevron and how courts have implemented that decision.”

The Tax Cuts and Jobs Act

The TCJA brought with it significant changes to the federal tax system and the need for Treasury and IRS guidance to assist taxpayers in navigating the new landscape. These changes included, but are not limited to, the new deduction for foreign-derived intangible income, or FDII, the new base erosion and anti-abuse tax, or BEAT, the new inclusion rule for global intangible low-taxed income, or GILTI, and amendments to IRC Section 163(j) limiting deductions for business interest expense. Treasury and the IRS have been working at a remarkable speed to issue published guidance in these areas, with various proposed and final regulations coming out since the TCJA was enacted. Some of the TCJA guidance has been welcomed by taxpayers; other guidance has been criticized as beyond the scope of laws enacted by Congress.

With significant tax issues and revenue at stake, the role of deference principles will be front and center in the coming years. This is particularly the case for Code sections enacted with a one-time effect and limited opportunity for taxpayer foresight and planning — e.g., Code Section 965 — and Code Sections for which regulations were or will be issued with retroactive effect to periods in which taxpayers undertook transactions in reliance on the language of the Code — e.g., Code Section 951A on GILTI.

Are Auer’s Days Numbered?

As noted above, the Supreme Court recently decided to revisit the question of whether any deference should be afforded to an agency’s interpretation of its own ambiguous regulations. Kisor v. O’Rourke,[7] will decide the sole question of “[w]hether the Court should overrule Auer and Seminole Rock” — the case upon which Auer is based. The decision to address this question is the culmination of Supreme Court justices’ questioning the doctrine’s continuing vitality for several years. Chief Justice John Roberts and Associate Justices Thomas and Samuel Alito have expressed doubts about the doctrine in the past, with Justice Thomas being particularly vocal in his belief that the doctrine violates the separation of powers.[8] With the recent additions of Associate Justices Gorsuch and Brett Kavanaugh, both of whom appear to be skeptical of expansive deference to agency interpretations, the stage is set for the overruling of Auer.

If Auer ends up on the chopping block, the next battleground may be Chevron deference. Justices Gorsuch and Kavanaugh have been critical of the doctrine in the past. And, recent majority, concurring and dissenting opinions reflect skepticism over the proper role of Chevron deference in deciding statutory interpretation questions. This approach appears to mirror the whittling away on Auer deference: Criticisms over the doctrine first surface in dissenting opinions and gradually make their way into concurring and then majority opinions.

Conclusion

Auer deference is particularly susceptible to challenge. Administrative agencies are often tasked with promulgating regulations that, in theory, should fill in gaps left by Congress and provide clear guidance. As the late Associate Justice Antonin Scalia and others have noted in the past, allowing an agency under the authority of Auer to later clarify its own ambiguous regulations, and to do so retroactively, arguably provides an incentive for the agency to draft ambiguous language that can later be interpreted in a manner that may not have been fully considered at the time of the original drafting. Chevron deference may also be subject to criticism, but at least it is understood that Congress cannot anticipate every issue that may arise and therefore expressly delegates authority to the agency generally — e.g., Code Section 7805 — or in the statute itself to fill in gaps. In contrast, Auer deference does not arise from a delegation of authority from Congress but rather constitutes a judicial doctrine that, in some cases, may result in a situation where the agency is no more capable of interpreting its own words than a court or a taxpayer. Additionally, Auer deference arguably runs counter to the well-established rule of lenity and the strict construction canon.

It is still too early to predict what will happen to the various deference doctrines, but even absent overruling of Auer or Chevron, it seems clear that courts are trending toward narrowly interpreting and applying these doctrines. This is significant for TCJA regulations, which will undoubtedly be tested in the courts in the coming years.